Distressed property, REO investments may undermine housing markets

Mortgage interest rates ticked down again in early August. But home buyers have already been spooked. They're worried that they can't afford to buy a house. And, in some cases, like when they're competing against hedge funds and private equity groups to buy homes, they're right.

Cash is king in this market. First-time home buyers are finding that simply having 3.5 percent to put down on an FHA loan isn't enough when you're doing battle with war chests in the billions (or at least the hundred millions).

The banks' REO departments favor cash over those who want to get a mortgage and start a life in that home. They figure a smaller amount of cash is better than a higher price if the latter comes with a mortgage contingency, an attorney contingency, and a request to fix the leaky roof.

The hedge funds and private equity investors plunk their cash down on the table and take the property in "as is" condition. Their team of rehab specialists will swoop down after closing, slap on some paint, install some new cabinets and appliances and put down a welcome mat for the next tenants -- who undoubtedly will be renters.

We've been wondering lately what happens when it's time for the hedge funds to goose their returns. It's one thing to build a portfolio of thousands of rental units, as some investors we know have. There, a $100 million fortune has been built on buildings designed to be rental units forever, some with commercial space on the ground floor.

But in single-family and town-house communities, known colloquially as "bedroom communities," there are no 100-unit rental buildings. These communities have grown up housing America's next generation of kids, and the ones after that. They have sheltered dreams of making a better life for that next generation, and housed the individual successes and failures that form the fabric of a family's life.

Hedge funds have bought into the idea that homes are just another great investment opportunity. But we're not talking about a failing business or even a single multifamily or warehouse building. Homes are different.

For one thing, they're located in neighborhoods that behave as living, breathing entities on their own. Local governments change relatively frequently, and those municipal shifts can dramatically affect how neighborhoods are taken care of, what gets fixed (and how quickly), the quality of schools (which directly affects neighborhood value), and so on.

And, as millions of Americans discovered over the past seven years, they're relatively illiquid as an investment. That means, you can't buy and sell a house as easily as a share of stock. Even if you sell your home to the first buyer who walks through the door on the morning you list it, it might take weeks or even months to close.

Hedge funds, not to mention "fix and flip" investors, are used to obtaining fast returns. And, surely, some will figure out a way to offload the risk associated with their home purchases and strip out the equity. But these homes won't house homeowners, at least not for years. And ultimately, having neighborhoods of renters instead of homeowners may not strengthen communities in quite the same way.

Only time will tell.

(Ilyce R. Glink is the author of many books on real estate and host of "Real Estate Minute" on her YouTube.com/expertrealestatetips channel. Samuel J. Tamkin is a Chicago-based real estate attorney. If you have questions, you can call her radio show toll-free (800-972-8255) any Sunday, from 11a-1p EST. Contact Ilyce through her website, www.thinkglink.com.)